How to profit from Britain's tourism boom
Our tourism industry has been and remains badly neglected by the government – but the fall in the pound means that it will boom regardless, says Jonathan Compton.
Successive governments have deliberately focused attention away from one of the UK's most important entrenched problems: the burgeoning current-account deficit. This is the difference between the value of goods and services which a country exports and imports. An ever-rising deficit is guaranteed eventually to produce unpleasant results including currency collapse, a run on foreign-exchange reserves, repressive taxation and higher interest rates.
In the first quarter of 2016 the UK's deficit reached a record £32bn or 5.4% of GDP. This is not only worse than the previous bad year, but has been deteriorating steadily since the late-1990s and is now the highest of any of the G7 economies. This deficit must be addressed or eventually the sure outcome is financial pain for us all. To tackle it, we need more foreign earnings.
Why tourism matters
Perhaps surprisingly, the UK's third largest source of overseas income after financial services and chemicals is not the well-known and successful sectors such as IT or armaments, but plain vanilla tourism. In 2015, a record 36 million foreign visitors spent a whopping £23bn, or about £700 per second, in Britain. We are the world's eighth largest international tourist destination ranked by visitor numbers and seventh by expenditure.
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Tourism, including the hospitality industry, employs over three million people across 250,000 businesses and is the third largest employer in the country. It accounts for nearly 10% of total employment, and contrary to popular belief more than 80% of the workers are British. Moreover, it has also accounted for nearly a quarter of all new jobs created since 2010 and is a vital source of income to the many people who need or want to work part-time.
One accidental outcome of the vote to leave the European Union has been the potential for a major boost to inward tourism and a significant improvement in the current account deficit, thanks to the sharp fall in sterling that followed the referendum. Tourism is highly exchange-rate sensitive. It is estimated that a 1% rise or fall in the exchange rate results in a 1.4% swing in earnings from tourism. The current dollar exchange rate of $1.30 is 21% below the ten-year average of $1.65. More important is the sterling-euro rate, since visitors from the EU dominate the business and account for three-quarters of all arrivals. So the current low exchange rate of €1.176 versus an average of €1.36 since the euro was created in 1999 is potentially a huge boon.
The majority of foreign visitors arrive for recreation overseas business people account for just over a quarter of the total and inward tourism is heavily biased towards London and the southeast. This is hardly surprising given the overall importance of London, its infrastructure, the number of major venues and the slightly better climate. For although the UK as a whole has one of the most interesting and diversified coasts in the world and truly terrific beaches, it would be disingenuous to suggest that these compensate for the temperature, drizzle and, in the northwest, murderous insects.
In both Cornwall and on the west coast of Scotland the annual averages show more than 1.5 metres of rain spanning at least 150 days with sea temperatures an agonising 11C, reaching mild frostbite peaks of around 15C in August. Yet tourism is proportionally often more important to these areas than the wealthier southeast; in West Somerset, for example, every fourth person is employed by or depends on the tourist industry, and even in Glasgow not a notorious go-to tourist hotspot tourism employs 10% of the workforce.
The funding gap
The underside of this vital industry is that we have a major deficit between receipts from incoming visitors versus expenditure by Britons travelling overseas. For all that the UK is a major global favourite for foreign visitors, there is an enormous deficit because Britons are inveterate travellers overseas. We made more than 80 million foreign trips in 2015, mostly to the EU and much paid for on credit. This penchant for abroad, however, is not just in response to our Arctic sea temperatures, but because domestic tourism is unnecessarily expensive. This gap is growing; in the year to May 2016 we spent an estimated £41bn on foreign trips leading to an overall "loss" on tourism of £18bn or more than a fifth of the current-account deficit for the same period.
This loss is likely to narrow in the short-term because of weak sterling, a slower rate of economic growth, maxed-out credit cards, and a widely reported misunderstanding that because we are due to leave the EU foreign travel will become more difficult. Even so, the structural deficit on tourism will remain. Yet the real issue is that the UK has one of the most inhospitable regimes for tourism of any leading destination.
The fault for this lies almost entirely with the government. Irrespective of the party in power the track record in recognising the economic importance of tourism, let alone providing support, has been woeful. In many leading tourist destinations there is a well-funded and staffed tourism ministry whose minister is of cabinet rank. France is the world's number one destination with 85 million visitors a year (more than twice the UK) and a healthy financial surplus in tourism; it has two well-staffed ministries involved in the business.
Here in the UK, responsibility rests with a sub-department within the minor and uninspiring "Department of Everything Else", also known as the Department of Culture, Media and Sport. The parliamentary undersecretary in charge of tourism is the unknown and junior MP Tracey Crouch. Tourism is but one of her various responsibilities which among others includes the National Lottery, Ceremonials and First World War commemorations. Crouch's prime interest appears to be football (she is a qualified FA coach).
Her support for tourism is barely visible and her voting track record in parliament shows hostility to the industry, including voting for higher taxation on plane tickets, higher VAT on services, the sale of state forests and stricter visa/immigration rules. She oversees the leading tourism quango VisitBritain, whose annual report groans with depressing platitudes and naive data such as "deliverable targets: we have 9,500 followers on Twitter" (fewer than Whiskas UK cat food). Tourism only hits the political agenda around elections, such as a keynote speech mention by David Cameron in 2010 extolling its importance. This was followed by silence and inaction.
Tourism globally is a major growth industry increasing by more than 6.5% a year for the last three decades. Yet Britain's approach to tourism is not just casually negligent, but to visitors is expensive and covertly hostile. Outward tourism from developing countries, such as India and China especially, is soaring. Tourists from China made the largest number of foreign trips last year at more than 175 million; yet to visit the UK a family of four must pay nearly £400 for UK Air Passenger Duty, one of the highest rates in the world and which on some routes has increased by nearly 400%. This is on top of the high cost for short stay visas for tourists, more than £80 in the UK compared with £50 for other European countries.
But VAT is perhaps the single most important issue. Of the 28 EU countries, the UK is almost alone in charging full VAT on tourist accommodation, on restaurant meals and on admissions to amusement parks. It is only one of six to apply full VAT to cultural attractions. There are so many other discouragements that according to a paper by the World Economic Forum in 2013, the UK ranks 138th out of 140 countries in terms of tourism price competitiveness. Small wonder that our share of China's travellers and many others is falling.
Punishing patriotism
Even worse, perhaps, the British public are being taxed higher than almost anyone else in Europe for patriotically taking a holiday at home. For all that foreign tourist receipts are important, in every country internal tourism is the larger slice of the hospitality pie. The British Hospitality Association estimates that cutting VAT on tourism could reduce the current-account deficit by £22bn. Other analysis has suggested that reducing tourism VAT to 5% would result in an increase in the tax take by £4.2bn.
Industry reports by firms such as PWC and Deloitte consistently highlight that reductions in taxes and duties can lead to higher overall revenue because of higher volume. Government funding is another issue. Always small, this continues to shrink to new lows. An outstanding example is the world's most popular urban parkland London's Hyde Park. It receives more than 80 million visitors a year. Yet funding for the Royal Parks has dropped from 80% of their total revenue ten years ago to a mere 30% today.
Another cost-cutting exercise included the abolition of the regional development agencies and the regional tourist boards. This left a vacuum so that apart from VisitBritain also known as VisitEngland, since other parts of the UK have their own equally poor arrangements tourism is coordinated by 200 disparate and inchoate local destination management organisations. And the elephant in the room of these funding issues is the question of new airports and runways. The repeated failure by successive governments to install new capacity is slowly weakening the whole tourist sector to the detriment of all.
The problems surrounding the UK's bungling approach to tourism are not new or unrecognised. Last year a cross-party House of Commons committee presented a somewhat flabby report on UK tourism which again noted the many areas for improvement, including many of those discussed above: to reduce VAT, ease visa restrictions, lower Air Passenger Duty and increase airport capacity. It also pointed out that the regulatory burden was "ill-fitted", training poor and the industry's importance underestimated. With minimal effort and cost, an intelligent approach to tourism would have many positive national results, not just to reduce the dangerously high current account deficit, but in terms of improving government revenue, employment, infrastructure and corporate profits.
Such an economic win-win is rare, but yet again it seems the government's focus is definitely elsewhere and the junior ministers in charge of a key industry are either ignorant or uninterested. Sadly, it seems that again this potential golden goose will be ignored. But notwithstanding government inertia, the UK will remain a major tourist destination and, for a while, more residents will holiday at home. I look at a handful of listed companies that should benefit below.
Five stocks set to benefit from a tourism boom
One of the largest and best-performing long-term plays on hospitality has been Whitbread (LSE: WTB), which operates more than 700 Premier Inns, 2,000 Costa coffee outlets and a number of restaurant chains. Unlike many hotel groups, Whitbread still owns many of its sites, so it is backed by solid assets. This has resulted in perennial rumblings of a takeover bid or a break-up into two separate companies. This may happen, but the company's steady record has been more important. Morgan Stanley analysts have a £51 price target for a 31% gain.
Shepherd Neame (SHEP: LSE) is the UK's oldest brewing and pub company, concentrated in the southeast, with a strong niche in traditional and craft beers. It still has family members on the board and owns or operates 338 pubs, hotels and restaurants. Its market cap of £178m looks too low given a multiple of only 12 times, a 2.5% yield and a strong balance sheet.
Far larger, with a market cap of £540m, and more London-centric, is Young & Co's (LSE: YNGA), another family-backed firm (the descendants of co-founder Charles Young still owe around a third of the shares). Apart from its pub operations it has started to move successfully into boutique hotels. Although superficially expensive at 21 times earnings, this reflects both a strong asset backing and a progressively rising dividend for the last 19 years. Both companies are much to be preferred to the asset-lite and over-borrowed pubcos'.
The share price of Merlin Entertainments (LSE: MERL) was hard-hit last year following a bad accident at its Alton Towers theme park, but the latest results in July showed a recovery. It is a pure play on leisure parks such as Legoland Parks, Madame Tussaudsand Shrek's Adventure.
It owns 111 attractions across 23 countries, but the UK accounts for 40% of revenue and Europe another 25% so it will benefit from a weaker sterling. Its valuation looks high on 23 times earnings, but this reflects its high-growth model and steady new attractions being opened. Merlin has the feel that Disney's theme parks did before hubris set in and is a rare large UK company involved purely in the leisure side of the tourism business.
I fly regularly on the Hungarian-controlled but London-listed Wizz Air (LSE: WIZZ). Its cheap and cheerful approach is reminiscent of Ryanair's early successes. The share price was a major casualty of the referendum, on concerns that its significant operations in the UK would suffer from falling passenger numbers to its many eastern European destinations.
But the company has already begun to redeploy its planes and personnel and I believe that the concerns are overdone. All airline stocks should carry a health warning given their operational gearing, but on a multiple of 12 times and with low fuel prices, Wizz Air's should rebound.
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Jonathan Compton was MD at Bedlam Asset Management and has spent 30 years in fund management, stockbroking and corporate finance.